VAT is the elephant in tax-policy room

The Davis Tax Committee is expected to release its report and findings on base erosion and profit shifting at the end of this month, which may have a "significant impact" on future policy decisions.

The committee has been given the unenviable task of reviewing the effect of the country’s tax structure on economic growth and employment creation. The ability of multinationals to erode the tax base by shifting profits to economies with lower tax rates, is regarded by many as a major evil in the tax system.

Finance Minister Nhlanhla Nene broke the bad news in his medium-term budget policy statement last month that the government’s costs had soared so high that taxes will increase next year.

The million-rand question is: how he is going to increase the tax pool in a shrinking economy?

The elephant in the room is value added tax (VAT).

Cliffe Dekker Hofmyer head of tax Emil Brincker says an increase in tax rates is not the solution to Mr Nene’s problem. "SA has a couple of other factors that need considering before rates are summarily increased," he says.

Individuals contribute 34.5% of the total tax revenue at present. Fewer than 7-million of the almost 17-million registered individual taxpayers contributed to personal income tax last year, a heavy burden on a few people.

An increase in the top marginal rate to 43% will not generate significant revenue, but it will send a message that there are efforts to balance the government’s books.

"An increase in the VAT rate will increase revenue substantially. It is really the only alternative, but it cannot be done in isolation and an increase in the top marginal rate may sweeten the deal," Mr Brincker says.

SA’s VAT rate has been 14% for many years, having increased only once from 10% to the current rate. China has a VAT rate of 17%, Russia 18% and India 5.5%.

The struggling economies of Portugal, Ireland and Greece levy VAT at 23% and Spain at 21%.

The 28% tax rate for companies is already higher than in most countries, including Egypt, the UK, Russia and China. Botswana has a company tax rate of 15%. Mr Brincker says SA cannot afford to raise its company tax rate if it wants to remain a global player.

PwC head of tax technical Kyle Mandy says tax policy, at its broadest level, involves a determination of the overall level of taxation in the economy (the government’s involvement in the economy) and the amount of tax revenue to be derived from tax instruments (the tax mix).

"Ultimately, a number of different and often competing objectives need to be balanced against each other. SA’s tax to gross domestic product (GDP) ratio is budgeted to be 26.5% in 2014-15. This ratio has been on an increasing trend since 2003-04 when it was at 23.2%," Mr Mandy says.

According to the World Bank, this is way above the world average of 14.5%. The African average is 14.4% and according to 2012 statistics from the Heritage Foundation, Egypt’s tax to GDP ratio was 15.8%, Nigeria’s 6%, Zambia’s 16.1%, and Zimbabwe’s 49.3%.

Mr Mandy says when most social security taxes are excluded, SA has the 10th-highest tax-to-GDP ratio in the world.

He says any reform to the tax mix would entail a shift from corporate and personal income tax to indirect taxes, and VAT in particular. Increases in VAT will act as a deterrent to the high levels of consumption, incentivise savings and reduce the reliance on unsustainable consumption growth.

Logan Hovells head of tax Ernie Lai King says the state wants to raise more taxes from a shrinking economy, which is not sustainable. "Everything should be geared towards making SA a more investor-friendly destination. We need new money and new input.

"The appetite for SA (as an investment destination) has undoubtedly declined in the past 20 months," Mr Lai King says.

SA’s increased tax-to-GDP ratio makes it more expensive to do business here, he says. He does not foresee an increase in the VAT rate next year, but predicts Mr Nene will be scraping the bottom of the barrel in his February budget.

"The problem with expanding the economy is the lack of guaranteed power supply, the lack of infrastructure — especially railway infrastructure — and the lack of skills in key government departments. We have security and crime issues, and the labour unrest is seen as a long-term problem," Mr Lai King says. He believes the solution is that the government ensures its people do what they are paid to do, and they be held accountable when they do not. "There is just a litany of dismal failures, but it is not irreparable," he says.

Mr Lai King studied budget speeches from 1983 to 1990 for his Tax masters degree, and has spotted a similar tone in recent budget statements — a hint of desperation.

"The difference is that the light at the end of the 1990 tunnel was a post-apartheid dividend. The only light now is to become an attractive foreign direct investment destination," he says.

The other elephant in the room is the lack of leadership to repair the damage.

WHY REGISTER WITH SAIT?

Section 240A of the Tax Administration Act, 2011 (as amended) requires that all tax practitioners register with a recognized controlling body before 1 July 2013. It is a criminal offense to not register with both a recognized controlling body and SARS.